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Actual Cash Value vs. Replacement Cost

When you are insuring your building or your business property you are given the choice between "actual cash value" and "replacement cost."

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Replacement Cost vs Actual Cash Value: What’s the Difference? 

What does "replacement cost" mean? What does "Actual Cash Value" mean? While you might be familiar with these two terms from your homeowners' insurance, how does it apply to commercial property insurance? Which one is the right choice for your small business?

When you are insuring your building or your business property you are given the choice between "actual cash value" and "replacement cost." We are going to talk about those two options and what their differences are so that you can decide which one you should opt for.

What is covered in this article:

  • The definition of replacement cost
  • The definition of actual cash value (ACV)
  • The difference between the two insurance options
  • Which option is the best coverage choice

What Does Replacement Cost Mean?

Replacement cost policies will pay you enough money to replace your property/belongings with “like-kind or quality” up to the limits of the policy you have. This should not be confused with the guaranteed replacement of your exact items. So if you lost a laptop in a fire, the policy is not going to replace it with a next-level replacement. Replacement cost coverage is going to provide you the cost to replace your computer with a similar computer.

Calculating the replacement cost is easy for items such as clothing, equipment, TVs, etc. However, calculating the cost to replace damaged property such as a building is going to be a little trickier. Insurance companies have to take into consideration the value of the building (including the cost of building materials and labor).

Your commercial property insurance may also include business interruption insurance to cover lost wages and profits or the cost of operating out of another location while yours is being repaired. 

NOTE: Did you know that in most cases insurance companies won’t give you money up-front to replace your damaged or stolen items? Some require you to purchase the item first—and then they’ll reimburse you. The cost of replacing the item is something you need to consider upfront when you purchase insurance coverage—and are choosing between actual cash value coverage and replacement cost coverage.

Extended or Guaranteed Replacement Cost

Guaranteed replacement—also referred to as guaranteed cost coverage—isn’t normally found in commercial insurance coverage. But if you are fortunate enough to have replacement cost coverage, the loss will be covered to replace the building to its original state, even if it means the value exceeds the policy limit. An extended replacement cost extends the coverage beyond your policy limits by a certain percentage, sometimes 10–20%. 

What is an ‘Agreed Amount Endorsement’?

An Agreed Amount Endorsement is “An endorsement to a policy made by the insurance company wherein it waives the coinsurance clause on the specified property. As long as this endorsement is in effect, there would be no coinsurance penalty at the time of a claim.”

What is Actual Cash Value Coverage?

Actual cash value coverage—or ACV coverage—is the amount of money that an item is worth minus depreciation for the wear and tear it has suffered since you purchased it. It’s often referred to as ‘fair market value’. So an adjuster with your insurance company takes the replacement cost of an item and calculates the depreciation to come up with the ACV. The calculation looks like this:

Replacement Cost x Percentage of Useful Life Remaining

Most items depreciate over time to the point where their value is minimal at best (unless—of course—it’s art, jewelry, antiques, collectibles, etc). Another way it can be calculated is to look at what dollar amount you could obtain for the item in question if it were sold today for current market value. Today's cost and today's prices are far different from those 10 years ago. That's why you must always consider depreciated value when making a decision.

What is the Difference Between Replacement Cost and Actual Cash Value? 

The largest difference between actual cash value policies and replacement cost insurance is how a destroyed or damaged item is replaced. A replacement cost policy pays for the full value of the item in question, whereas actual cash value policies pay for the depreciated cost of the item. 

Secondly, actual cash value usually consists of a lower premium than replacement cost because you’re not being paid the full original value/actual cost of the items and/or property. Conversely, replacement cost will consist of higher premiums and potentially a higher deductible at the time replacement or repair is necessary. The difference in the cost of the premium can be substantial.

You'll want to take into account the value of your business and personal property to choose between the two coverage options.

Actual Cash Value vs Replacement Cost: Which Option is the Best Choice?

Choosing the right coverage that's the best fit for your business is difficult. Because actual cash value is cheaper and more affordable, it may seem like the easiest choice. However, if you were to lose your property in a fire, you’d only get part of what it costs to repair or rebuild. Is your small business financially prepared to make up the difference in cost? If your business is prospering and you have the means to replace your building if necessary, then perhaps ACV is the best coverage option. 

A full replacement cost policy may be more expensive, but it gives you peace of mind if your property was robbed or damaged. Your mortgage lender (or leaseholder) may require you to pay for full replacement cost to protect their investment. Be sure to look at your mortgage and any other business loan agreements carefully.

How these Terms Apply to a Property Insurance Policy

Whether it's home insurance, homeowner's insurance, or commercial property insurance, you need to be familiar with these terms. Actual cash value and replacement cost are meaningless if you suffer property damage that is not a covered event. Be sure to be familiar with what your insurance company covers so you're not the one that has to pay the costs for repair or replacement.

How Much Will You Be Paid for a Claim?

Regardless of the policy you choose, the personal property you’re insuring needs to be well-documented to receive the proper coverage for a covered claim. If your business keeps detailed inventory records this may be sufficient. If your business contains any valuables—such as antiques—make sure they’re appraised and you’ve kept a record of their worth off the premises. 

The payment you'll receive for a covered loss varies significantly depending on the insurer, the depreciation of the covered items, and even what your deductible is.

Get a Free Quote

Debating actual cash value vs replacement cost can be tricky (with homeowners insurance or commercial insurance). We encourage you to speak to an insurance agent who is knowledgeable in the area that can help walk you through the different coverage options (even guaranteed cost coverage).

Complete the form above to start the process of getting a quick, free quote for your commercial insurance, or call us at 1-877-907-5267 to speak with one of our specialists for guidance in finding a policy that fits your requirements.

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